Austerity Chic

Yet there are many Americans who spent the last eight years living within their means, and have plenty of resources left. For those Americans, the ones with cash in their bank accounts, this is the time to spend.

Cracking open the Champagne does not exactly feel in tune with today’s spirit of national austerity, but recessions get worse when prosperous people do not spend. In fact, if you can afford it, then this is exactly the moment to redo your kitchen or buy a car. Not only will you be able to get a good deal, but your spending will help revive the economy. The economist John Maynard Keynes convincingly argued 70 years ago that thrift was no virtue during a recession.

Despite the strength of the economic logic urging spending during a downturn, powerful psychological forces push in the opposite direction. America is hurting; thousands are losing their jobs. In today’s political climate, public displays of prosperity are the kind of thing that gets you lambasted by a Senate subcommittee.

Most of us won't lose our jobs, won't face a pay cut. Yet we tighten anyway. Dollar-stretching tips circulate even among the most comfortable. But if your paycheck's intact and you're still cutting back, you may be part of the problem.

When home values surge, we tend to feel richer and spend a bit more, even if we don't plan to sell the house. Economists call this “the wealth effect,” and it's got a recessionary flip side. So when our 401(k)s dive as the economy hits a rough patch, we feel a bit of a pinch and rein in consumption — even when our incomes and the long-term value of our investments hasn't changed a bit. In short, we don't always look to our personal financial fundamentals when choosing whether to splurge or scrimp.

But just as “irrational exuberance” can keep a speculative bubble afloat, equally irrational anxiety, and the ethos of austerity it produces, can trap us in the doldrums. So maybe you went a bit crazy during the boom, and now's the time to return to financial sanity. Good! But if you were living comfortably and responsibly within your means last year, you probably don't need to cut back now.

You know what? This argument DRIVES PEOPLE CRAZY. Check out Glaeser's comments, and mine, which tend to confirm that there is in fact a Keynes-ish sort of pack psychology about appropriate consumption behavior. It's funny that people get upset by a recommendation to do things that are both individually prudent (it's just good financial stewardship to buy things when prices are low) and that have larger than ususual positive spillover effects. I doubt people really think it's better to leave yourself and everyone else worse off. My diagnosis is that most people either don't get the idea of periodic downturns and recoveries and so tend to suspect with each serious recession that this time everything may go to shit permanently (which is true, it might, but what are the odds?) and to infer that prudence demands hoarding. My biggest worry about things going to shit is that government profligacy may leave us with a worthless dollar. But then why not spend all your dollars now on durable stuff! I recently put a lot of my savings into a diamond ring, which I'm now thinking turned out to be fairly savvy move in several different ways.